With plummeting sales, franchisees face a brutal future

The coronavirus shock is putting considerable pressure on franchisees large and small, and franchisors are already taking steps to ease the problem.
Photograph courtesy of Haila Maze

Jeff Offutt thought this was going to be a good year. Sales were up at the 50 restaurants he operates in Missouri, including Subway locations, Five Guys and Moe’s Southwest Grill. Just three weeks ago, he was gushing to his team about the company’s improved margins.

And then the coronavirus panic hit. Last Wednesday, he said, his Subway restaurants were up 11%. By Saturday, they were down 41%. That’s a 52-point swing in three days.

“I thought 2020 was going to be our best year in 10 years,” Offutt told Restaurant Business. “It’s amazing how that perspective changes in three weeks.”

As restaurants close their doors and workers place chairs on tables, close up drink stations and put signs on doors, many of the people hoping for customers to come in for some takeout are franchisees.

These operators face financial ruin in the coming weeks as customers stay home. And both large and small franchisees are in the same boat. Small operators often can’t handle a month or two of little to no sales. And a surprising number of large-scale franchisees operate with little room for error.

It’s increasingly expected that many franchisees could go under as their finances take a massive hit from a month or two of weak or nonexistent sales. The problem could put significant pressure on franchisors to take steps to protect their operators and keep their systems from collapsing.

“If the franchisor does not take action to protect those franchisees by providing them financial relief—not deferral, but rather abatement of the royalties and other expenses—they’re going to experience a tremendous wave of units closing,” said Robert Zarco, an attorney who represents numerous franchisees. “It’s going to be a big deal.”

A number of franchise systems are already taking steps to help their operators. The 44-unit fast-casual chain Little Greek Fresh Grill is waiving its royalty charge this month. MTY Food Group, which owns Papa Murphy’s and several other franchisors, said earlier this week that it would postpone royalty collection starting Tuesday.

Even giant McDonald’s Corp. suggested this week that it would consider rent deferrals to help its owner-operators get through any sales slump or closure. That’s a rare offer for the Chicago-based burger giant: The company offered rent deferrals to New York City operators following the Sept. 11 terrorist attacks, for instance.

“We’re going to do whatever is necessary to help any other owner and partner,” CEO Chris Kempczinski said on a video this week. “We will not let you fail.”

As it was, many large-scale franchisees that had built their businesses using a lot of debt were already facing a challenge. NPC International, the largest franchisee of both Pizza Hut and Wendy’s, was considering a bankruptcy filing.

Earlier this year, Carrols Restaurant Group, a 1,000-unit Burger King operator, cut in half its expected spending on remodels to collect cash to pay down debt.

The coronavirus is doing it no favors. This week, Moody’s ratings service downgraded Carrols’ credit rating and gave it a negative outlook.

“The weakness in Carrols’ credit profile, including its exposure to potential unit closures, have left it vulnerable to shifts in market segment in these unprecedented operating conditions, and Carrols remains vulnerable to the outbreak continuing to spread,” Moody’s wrote.

Small-scale franchisees are especially vulnerable, especially in systems that may not have drive-thrus or sophisticated delivery options to help carry restaurants through difficult times. A number of smaller franchisees have told us privately that they face serious financial problems in the coming months. “This will ruin me,” one said.

Offutt said he went two days with just three hours’ sleep as he pulled all-nighters trying to find a solution.

“We have to get as conservative as possible, and once we get there, it’s not conservative enough,” he said. “Everybody is cutting as quickly as we can. We have to cut to the bone and make it hurt.”

Restaurants can consider closing, for instance, but even then, they still have to make rent payments. So even operators with little to no debt can struggle to survive a couple of months with little to no sales.

Keith Miller, a Subway operator and franchisee advocate, said that royalty abatement might not help many franchisees if they’re not making money. “If we get no sales, we pay no royalties, either,” he said. “That doesn’t even help right away.”

Miller said that franchisors’ first step should be to protect operators from banks. During the credit crunch and recession more than a decade ago, many lenders terminated franchisees’ loans and called lines of credit that were due.

Many franchisees are going to be using their lines of credit to get through this difficult period.

Jordan Myers, a partner with Atlanta law firm Alston & Bird, anticipates that struggling franchisees could stop paying their landlords, franchisor and lender, and then work out an abatement with the franchisor and landlord and a payment holiday with their bank. 

Zarco said franchisees need to focus on staffing up takeout and delivery to make sure they can serve customers in those areas. He also said franchisees should hold off on closing their dining rooms until forced either by the state or local government or their franchisor.

That way, their insurance is more likely to pay a claim, because many policies consider a pandemic to be an exception. “But those same policies, especially the business interruption policies, have provisions that if your business is shut down as a result of some government action, then that is a covered expense,” Zarco said.

As for Little Greek, the company is doing everything it can to make it through the coming months. Sales at the chain are already down 20% to 40%. By comparison, sales at the casual-dining chain company that president Nick Vojnovic ran during the recession were down half that.

“We try to plan as best as we can to keep moving forward,” he said. “And keep what sales we can keep.”

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